New BMO Funds Come in Several Flavours

March 28, 2013

This week BMO announced more additions to its line of ETFs. What’s most interesting about these new funds is not so much the asset classes they track, but the fact that each comes in two or three flavours.

  • The first group focuses on US dividends. Like the BMO Canadian Dividend ETF (ZDV), the new funds do not track an index: instead they use a rules-based methodology to select 100 companies based on dividend growth rate and payout ratio as well as yield. But here’s the fresh angle: the fund comes in three versions: one uses currency hedging (ZUD), while the others are non-hedged and trade in your choice of Canadian (ZDY) or US dollars (ZDY.U).
  • A second trio of ETFs is devoted to mid-term US investment-grade corporate bonds, which have maturities ranging from five to 10 years: that contrasts with the iShares U.S. IG Corporate Bond (XIG), which has an average maturity of about 12 years. Again, the fund is available with currency hedging (ZMU) and in non-hedged Canadian (ZIC) and US-dollar (ZIC.U) versions.
  • Next up is a pair of low-volatility US equity ETFs, based on a strategy similar to that of the BMO Low Volatility Canadian Equity (ZLB). As I explained in an earlier post, several strategies can be used to build low-volatility ETFs: this one zeros in on the stocks with the lowest beta in the S&P 500. The fund is available in Canadian and US-dollar versions, and both are unhedged. (Currency hedging would interfere with a low-volatility strategy.)

I’m pleased to see an ETF provider offering these kinds of options. For many years, almost every foreign equity ETF in Canada used currency hedging, apparently in response to demand from advisors. Indeed, ZDY is the first Canadian ETF of US dividend stocks that does not use hedging.

Hedging worked well in the mid-2000s and other periods when the Canadian dollar rose dramatically, but over the long term it causes a drag on equity returns and may even increase a portfolio’s volatility. Ideally, investors should have the option to buy hedged and unhedged versions of US and international equity ETFs, and that’s starting to become reality: in addition to these new products, both BMO and Vanguard now offer two versions of their S&P 500 ETFs. We’re still waiting for similar options with international ETFs, but I suspect we’ll see them soon.

H&R Block tax giveaway

Planning to file your own taxes this year? Once again, H&R Block is offering three readers a chance to use H&R Block At Home for free. This is an online service, with no download required (regular price is $15.95 for the first return and $10 for a second family member). Enter the draw below:

a Rafflecopter giveaway

{ 22 comments… read them below or add one }

Michael March 28, 2013 at 1:53 pm

This is interesting.

It’s good to see more ETF products introduced in Canada.

Jon Parry March 28, 2013 at 2:41 pm

The ongoing evolution and innovation in the ETF space in Canada is providing a number of outstanding opportunities for individual investors. BMO ETFS is to be congratulated!

DaveL March 28, 2013 at 4:07 pm

Hi Dan.

Can you comment on the tax treatment of the dividends from ZDY (the EFT that trades in Canadian dollars) if held in a non-registered account? I’m assuming the dividends are still treated as “other income” and are not illegible for the dividend tax credit. I’m also assuming any change in value would be treated as capital gains / losses (when sold).

Keep up the great work!

Potential Sunbird March 28, 2013 at 9:32 pm

Hi Dan, a similar question to DaveL, any idea of the tax implications (in a non tax sheltered account ) of ZDY.U trading on the TSX compared to say a Vanguard dividend focused ETF trading in New York. Thanks so much.

Canadian Couch Potato March 28, 2013 at 10:34 pm

@Sunbird: ZDY, ZDY.U and New York-listed ETFs that hold US stocks will all be taxed identically in non-registered accounts. What’s important is the underlying holdings: dividends from US companies are always fully taxable as foreign income, and they are subject to a 15% withholding tax, which is recoverable by claiming the foreign tax credit.

Potential Sunbird March 28, 2013 at 10:53 pm

Thanks Dan, I had assumed that the ETFs based on the swap based method would be ” sheltered ” from tax until they were sold and be liable for capital gains.

Canadian Couch Potato March 28, 2013 at 10:57 pm

@Sunbird: None of these new BMO ETFs use swaps. Did I misunderstand your question?

Potential Sunbird March 28, 2013 at 11:08 pm

Then how do they trade on the TSX using US equity?

soso March 29, 2013 at 10:34 am

Following the questions from DaveL and Potential Sunbird: what is the tax implication of using in ZDY or ZDY.U in:

1) RSP
2) TFSA or RESP (I am assuming the answer is the same for these types of accounts).

I am looking for a tax efficient way to have foreign exposure (either US or international) in my TFSA and/or RESP and I am yet to figure it out. So far, I have kept all my foreign exposure in my RSP and I keep only Canadian ETFs/bonds in my TFSA and RESP. The consequence of this right now is that my returns on my TFSA and RESP have not been so great. I setup my DIY account just 4 months ago…

Regent Lapoionte March 29, 2013 at 10:58 am

This is excellent news !

I just hope that Vanguard and Blackrock will follow the BMO example so that we will have in Canada a better choice of ETF’s when we decide to invest in the USA or internationally.

Death and Taxes March 29, 2013 at 11:24 am

So if we buy them in a TFSA we are unable to claim the 15% witholding tax right?

Canadian Couch Potato March 29, 2013 at 11:24 am

There seems to be a lot of misunderstandings about US equity ETFs that trade in both Canadian and US dollar versions. The USD versions do not use swaps or any other derivatives. The two versions are identical in every way except the currency you use to buy and sell them. There is no difference in the holdings, or the way they are taxed, or in your currency exposure. The only reason to use the USD version is because you happen to have US dollars and you don’t want to convert them to Canadian dollars.

@Soso: Holding US and international equities in TFSA or RESP is quite tax efficient, since all income and capital gains are tax-free. The only issue is the withholding tax on dividends, which amounts to only about 0.3% annually for US equities, or $30 a year for every $10,000 invested. With international equities, it’s even less.

And if you are using Canadian ETFs to get foreign equity exposure in your RRSP, you’re paying the withholding tax there anyway. The only way to be exempted from the US withholding taxes in an RRSP is to use a US-listed ETF. There is no way to avoid the international withholding tax in an RRSP.

Russell March 29, 2013 at 1:10 pm

Great article Dan! Do you prefer VTI over ZDY in the complete couch potato?

HarveyM March 29, 2013 at 7:25 pm

The proliferating etf population is only going to send more and more investors to you Dan for advice! Investors will surely get more confused by all the choices. These are expensive new etfs. ZDY has a MER twice that of VFV for example yet offers only one fifth the diversification of the latter. These are not for properly diversified passive indexed portfolios. Surely not? They don’t make sense to me!

Paul G March 29, 2013 at 10:35 pm

Given the 15% tax on dividends, I don’t see the US dividend ETF as being real interesting…

15% is expensive for currency hedging…

Death and Taxes March 30, 2013 at 4:49 am

Well if BMO’s low volatility offering can beat or at least duplicate the performance of SPLV (which is even kicking SPY’s performance)it could have some promise in this current bull market. Most Canadian stocks have trended sideways as of late or even gone downhill(like HXT for example) while the US markets have been steadily building steam.

Eric March 30, 2013 at 7:03 am

Not related to this particular post, but I wanted to say that you blog has been of great help to me in the last weeks. At 25, I have a good amount of cash that “sleeps” in the bank and a TFSA that does the same, but I’m starting on a RRSP. Through my employer, I have access to 4 index mutual fund (not ready for ETFs yet) from Manulife, with a MER of 0.225, although I think it doesn’t include all fees. Anyway, I’ll apply the Couch Potato method to my RRSP, and may also transfer my TFSA. Just wanted to say thank you.

Canadian Couch Potato March 30, 2013 at 10:31 am

@Eric: Thanks for the comment, and glad you’ve fund the site helpful. If you can get index funds at work for 0.225%, you don’t need ETFs. Do check to see if there are additional fees, but group RRSPs ca be an excellent vehicle, especially if there is some company match.

@Jungle: It should not be a problem to do Norbert’s gambit with ZSP/ZSP.U, but before attempting it, it;s best to simply ask your brokerage if you can journal these securities from one side of your account to the other.

Jungle March 30, 2013 at 5:56 pm

Thanks again and look forward to reading your blog.

Jungle

Raman March 31, 2013 at 9:48 pm

Thanks for the info, Dan. I appreciate your thoughts that Vanguard might introduce some non-hedged products in the future. Out of curiosity, if they are introduced, do you expect that there will be a way for people holding some units of the hedged ETFs (such as VUS.to) to “convert” their holdings into the non-hedged versions? This way we can skip out on having to pay capital gains taxes and so on. I know this is aspirational thinking, but we can dream…

Canadian Couch Potato March 31, 2013 at 9:53 pm

@Raman: I don’t think Vanguard could do that even if they wanted to. Corporate-class mutual funds allow this kind of thing, but the ETF structure would not permit it.

Anton April 1, 2013 at 9:59 am

Great article. Good to see more passive ETF options.

Leave a Comment

Previous post:

Next post: